Is Private Equity Having Its Minsky Moment?

It’s Michael Milken’s Economy.

By Matt Stoller and cross-posted from his blog, BIG

In 1993, economists George Akerloff and Paul Romer wrote a paper on the conjoined two crises of 1980s finance. The first was mass junk bond defaults late in the decade, and the second was the savings and loan crisis of deregulated banks going bankrupt en masse as they engaged in an orgy of self-dealing and speculation. The paper was called Looting: The Economic Underworld of Bankruptcy for Profit, and in it, they described how financiers can profit by destroying corporations, using a particular strategy. “Our description of a looting strategy,” they wrote, “amounts to a sophisticated version of having a limited liability corporation borrow money, pay it into the private account of the owner, and then default on its debt.”

What Akerloff and Romer were basically talking about was a legal version of the bust-out scene from Goodfellas. In that movie, mobsters took an ownership stake in a restaurant they often frequented, and then used the restaurant’s credit to buy liquor, which they would move out of the back and sell at half off. When the restaurant’s credit was all used up, they burned the restaurant to the ground to collect the insurance money. It was an intentional bankruptcy, a theft from creditors by those who had control of the restaurant and did not care what happened to the asset in the end.

A bust-out requires the ability to borrow from someone, so that you can steal from the people lending you money. This is also true for its white collar cousin. So the trick, for both the mobsters, and the white collar looters described by Akerloff and Romer, is to find a way to borrow money. I’m reminded of this paper, and the bust-out scene in Goodfellas, because I’ve been trying to understand what is happening with private equity as the Coronavirus induces a massive, if short-lived, shock to our economy.

The reason I’m reminded of this paper is because private equity is a business created in part by junk bond takeover specialists in the 1980s, who were the topic of Akerloff’s and Romer’s paper. What’s interesting about junk bond specialists is that they had a more insidious plan than the mobsters in Goodfellas. Mobsters just stole from the bank, which did not know that the restaurant had become an object to be looted. But financiers of the 1980s actually captured control of the bank

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